The Hindu Business Line : Dividend, tax gains for MF investors

While returns earned on the growth option will be subject to a 10 per cent (long-term capital gains) tax, the returns earned by way of dividends will be subject to a higher 12.5 per cent tax.

THE budgets of the past few years have made a series of flip-flops on the taxation of returns that investors earn from mutual funds. Budget 2003 has the following proposals for investors in mutual funds:

Investors, once again, will not be required to pay tax on dividends received from mutual fund units at the marginal rate applicable to them. Instead, mutual funds will pay a distribution tax amounting to 12.5 per cent of the dividends declared.

Dividends from equity oriented funds and UTI-I (which houses the assured return schemes of the UTI) will be exempt from this distribution tax for one year, starting April 1 2003, making such dividends entirely tax-free.

Investments made in listed equity shares, for one year from April 2003, will be exempted from long-term capital gains tax. But investors will still have to pay long-term capital gains tax on their mutual fund investments.

Tax will now be deducted at source on dividends declared by mutual funds, only if this income exceeds Rs 2,500 per annum (Rs 1,000 earlier).

Implications for investors

For debt fund investors who fall in the 20 and 30 per cent tax brackets, effective returns from the dividend options will be significantly higher than before. But debt fund investors who now enjoy a tax-exempt status, or those in the 10 per cent tax bracket, will be left with a lower effective return from the dividend option, since they will have to bear distribution tax at 12.5 per cent, irrespective of their marginal tax rate.

The growth option of a debt fund will remain more tax-efficient than the dividend option. While returns earned on the growth option (through capital appreciation, if held for over a year) will be subject to a 10 per cent (long-term capital gains) tax, the returns earned by way of dividends will be subject to a higher 12.5 per cent tax.

In equity funds, the dividend option will now be more tax-efficient than the growth option. While returns distributed by way of dividends would be completely tax-free, returns earned by investors by way of appreciation on the Net Asset Value, in the growth option, will be subject either to short-term or long-term capital gains tax.

While the appreciation from a direct investment in stocks will be exempt from long-term capital gains tax, returns earned from equity mutual funds through NAV appreciation will be subject to tax at 10 per cent.

Investors in mutual funds can heave a sigh of relief that the Kelkar panel's proposals about imposing a tax on short- term capital gains and interest income earned by mutual funds has been ignored in the budget. These recommendations, if implemented could have sharply enhanced costs, and trimmed effective returns from both debt and equity mutual fund schemes.

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